What Next? Wine Industry Mid-Year Report & Preliminary Brexit Analysis

economist-cover“What next? was the question I asked to open my report at the Unified Wine & Grape Symposium‘s “State of the Industry” session in January. Risk and uncertainty were my forecast for 2016.

Bernie, Donald, Zika, Brexit. Look out! Anything can happen, I told the audience, although I ended with a Frank Sinatra theme. It could be a “Very Good Year” if we can dodge the many potential hazards.

I wasn’t the only one who was worried. Four speakers in a session on wine industry investment were asked about their expectations for 2016. All four said that the prospects for the U.S. wine industry were bright … unless something happened to the economy.

Cautious Optimism?

We are halfway through the year and the cautious optimism expressed earlier seems justified. The U.S. remains one of the few large economies to be growing, for example, and unemployment rates are low. The June jobs report offered evidence of further recovery. But confidence in economic growth seems very fragile and the Federal Reserve has hesitated repeatedly to raise key interest rates.

One worrisome indicator is the yield curve, which tracks the difference between short- and long-term interest rates. The yield curve has become unusually flat recently, a pattern that is sometimes associated with economic slowdowns. A  recent Deutsche Bank analysis of the yield curve forecasts a 60% chance of a recession in the U.S. in the next 12 months. Yikes!

Interest rates around the world are so low (and sometimes even negative) that policy makers are worried. What if something goes wrong? How can we push interest rates even lower? Would it make any difference if we did? With fiscal policy handcuffed by political chaos in many countries and monetary policy seemingly out of ammunition, there is concern that a crisis in one country could easily spread to others.

What next? That’s still the right question, both in general and when it comes to wine. While the U.S. wine market continues to grow and attract the attention of international competitors, the Nielsen figures reported in the July 2016 issue of Wine Business Monthly suggest caution. Off-premise wine sales increased by a rate of just 1.1 percent overall in the four weeks ending April 23, 2016, indicating a possible deceleration of earlier more healthy growth.

Brexit’s Many Potential Impacts20160702_cuk400

The list of potential challenges and threats is very long but the U.K.’s vote to leave the European Union (a.k.a. Brexit) is at the top of most lists. What does Brexit mean to the wine business? The answer is that it is too soon to be sure, but here is a quick guide to what to look out for and the impact on wine.

The biggest impacts of Brexit to far have been political, with the heads of the Conservative Party and the nationalist UKIP group both resigning (for very different reasons) and Labour’s leader under sharp attack from his own members. Since British tax policy has been a significant burden on wine sales there in recent years, the uncertainty about the who will lead and where she (Theresa May will take over as Prime Minister in the next day or so) will want to go is significant for wine.

The partial political vacuum in England has seemingly increased the influence of Scotland’s talented leader Nicola Sturgeon, who suggests that Scotland might once again consider leaving the U.K. (a Scexit?) in order to remain closely linked to the E.U. Sturgeon has taken strong anti-alcohol positions, which could affect wine policy, although this is way down the list of things to worry about if Scotland breaks away and the U.K. breaks apart.

Financial markets react to news more quickly than the “real” economy and the rise of the U.S. dollar and fall of the British Pound are the most visible effects so far. The Pound has tumbled dramatically as the graph above show and some observers believe that it will continue its descent although this is far from certain.newfx

Short Run: Exchange Rate Effects

The falling Pound is important because, as this table of U.S. exports for the first quarter of 2016 from Wine by Numbers indicates, the U.K. has become a more important market for U.S. wine exports in recent years. The U.K. is second to Canada in U.S. bottled wine exports and first in the bulk wine market.

The falling Pound makes imports from the U.S. and other wine nations more expensive in the U.K. U.K. consumers are notoriously price sensitive, so the falling Pound could produce substantial wine demand impacts, especially if there is a U.K. recession, as many expect, due to falling investment (see below).


The exchange rate effect will hurt U.S. exports to the U.K., but the biggest impacts will be on other countries that rely upon the British market to a greater extent than we do. Australia, South Africa and of course European wine producers will take a bigger hit.

The problem is compounded by the fact that supermarkets are a critical sales vector in the U.K. and much of the food they sell is imported and will therefore be more costly to source. Supermarket margins are likely to be squeezed as they attempt to pass on higher costs to consumers with uncertain economic prospects.

Don’t be surprised if this puts pressure on foreign wine suppliers to cut their wholesale prices to British supermarket buyers and thus absorb some of the exchange rate impact. That is an incentive to develop alternative markets … such as the U.S. The margin wars are just getting started.

So the wine news is not very good in the U.K., where wine prices are likely to rise, incomes could fall, wine taxes may also increase, margins come under attack, and prohibitionist forces may be strengthened. Bad news for the British who drink wine and bad news for others including U.S. producers  who want to sell it to them.

Long Run: The Vultures Circle

But the biggest impacts are likely to be the long-term structural changes that will be required if and when Britain or England or whoever is left leaves the European Union and the single market. The U.K. is an important wine center both because of the large British domestic market and also because of its essentially unrestricted access to European markets and resources. It is too soon to know how this will change for wine, but it is instructive to watch other sectors to get a sense of the dynamic.

There is already concern about disinvestment in British steel and automobile manufacturing, for example, if resources are shifted into other E.U. zones. Much of British auto production is exported and would be disadvantaged if the U.K. loses its open access to E.U. markets. Voters in Sunderland may eventually rue their strong Brexit support if Nissan moves production (and some of the current 7000 factory jobs) away from its big plant there to new homes in the E.U. heartland.

And everyone in The City, London’s big financial center, is openly concerned, too. London residents voted overwhelmingly to remain in the E.U. in part because of their desire to protect The City’s economic standing (and their jobs), which would diminish if movements of capital and skilled workers to and from the continent were restricted.

Any major disruption in The City will have widespread impacts on wine, especially the on-premise trade but not limited to that. The vultures (in the form of European cities hungry for those high-paying finance jobs) have already started circling.

I am still cautiously optimistic for the U.S. wine economy and for Britain, too, but there are lots of risks to consider. That question — What Next? — still applies.

How Much Has the Strong Dollar Affected U.S. Wine Exports?

loonieLast week I wrote about the strong U.S. dollar and its impact on U.S. wine imports. My conclusion was that there was an exchange rate effect, but it was less than you might otherwise expect because of specific factors that are at work in the sparkling, bulk, and bottle wine import markets today.

This week we turn to U.S. wine exports. Econ 101 tells us that a strong currency discourages exports by increasing their cost to foreign buyers and this is an important factor. Thus, for example, we would expect U.S. wine exports to Canada to have fallen over the last year.

Loonie Times

The U.S. dollar has appreciated  dramatically against Canadian dollar (or “Loonie,” as they call it) over the past two years. After coming close to parity in 2014 the Canadian dollar nose-dived and it now takes in the neighborhood of C$1.45 to purchase one U.S. dollar.

After weathering the global financial crisis better than most countries, Canada has fallen victim to its dependence on natural resource exports, especially oil exports. As the price of oil has fallen the foreign exchange value of the Canadian dollar has plunged, which raises the cost of imports for Canadian buyers. They are feeling the pain.

How bad is it? The New York Times reported that the combination of drought in California, which raised agricultural goods prices, and the falling Loonie has resulted in  soaring imported fruit and vegetable prices. How high? Eight dollars for a head of cauliflower! Yikes!

Canada is largest single market for U.S. bottled wine exports so you would expect this situation to depress wine sales to Canada and to have a similar but perhaps smaller effect in other countries where the exchange rate shift has not been as extreme. Has it happened? Let’s look at the data.

us ExportsU.S Wine Exports by the Numbers

Here are wine export data for the first three quarters of 2015 as as provided by Wine by Numbers, a publication of the Unioni Italiani Vini (click on the chart to enlarge). These data show that U.S. wine exports actually increased in the time period covered here rather than decreasing as theory predicts. The story varies from country to country (as it did with imports), but the overall trend is to higher exports — exactly opposite of the textbook prediction. What gives?

A first answer is that perhaps it takes more time than has passed so far for the higher exchange rate value to pass through to higher import prices, higher wholesale prices, higher retail prices and then for the quantity effects (lower depletions, lower reorders etc) to funnel back. International finance theory has a whole chapter on how these lags can create distortions. There is something to this lag theory, but I think there is more going on.

A second factor, especially on higher value bottled wines, is branding strategy. Rather than raise price and lose market share, it is possible that some big players are absorbing lower margins to keep on the shelves and in the game abroad. How long can they do this? Some Argentinean wineries have been doing it for three or four years so far here in the U.S. It’s expensive, but could be worthwhile if things turnaround before too long.

A third factor, which applies especially to the bulk wine market, is that U.S. tanks are full of these wines with no indication that domestic consumer demand for them will pick up soon. Better to sell them off abroad as bulk exports than dump them out when they are too old and tired to find buyers.

A final piece of the puzzle is the duty drawback program, which I wrote about last year. This is a very peculiar U.S. government program that under some circumstances will refund import duties for a winery if it exports a similar U.S. wine abroad. Sometimes this makes it seem like exports subsidize imports and, as now, it might be true that imports provide rebated duty funds that can subsidize exports. To be honest, I am not really sure of the net effect except to say that there is an incentive for large integrated wine companies to balance imports and exports.

As we saw last week, while bulk wine imports have not surged due to the exchange rate effects, they have remained significant. This fact means that, for certain companies (especially larger wineries) importing and exporting the right wines to and from the right places, duty drawbacks can be significant.

General Conclusions

Looking back over these two columns, the first conclusion is that so far in this cycle the pure foreign exchange effects have largely been offset by specific forces in different sectors of the wine business and in different countries. Exchange rates matter, but they are just one of many forces at work. Since those forces are likely to be different in the future, it is important to be cautious in projecting these trends ahead too far.

I used to warn my students against trying to forecast foreign exchange rates. Too many variables. Too many unknowns. Exchange rates are the most difficult thing in economics to predict, I would tell them. But now I know that I was wrong. Wine trade may be more difficult because it is affected by all the forces that hit the exchange rate and a whole lot more.


I encourage readers to drill down in the data provided here because there are a lot of individual country stories to be examined along with the big picture analysis I have provided here.


How Much Has the Strong Dollar Affected U.S. Wine Imports?

euroAbout this time last year I wrote a column that analyzed how the rise in the U.S. dollar’s international exchange value was likely to impact the wine market. My conclusion was that the simple Econ 101 rule that a stronger currency leads to higher imports and lower exports might not perfectly apply to wine. I cited research from the falling dollar era to support the idea that the impacts would be different in different market segments and for different sets of countries.

So it is a year later now and enough time has passed to begin to see some impacts. What is the story so far? I’ll review the exchange rate effects and focus on imports this week. Next week’s column with analyze U.S. wine exports and try to draw some broader conclusions.

The Strong Dollar Storyoz

The U.S. dollar has increased in value dramatically over the last two years relative to several important currencies, making products from those countries potentially cheaper to U.S. buyers. The euro, for example fell from almost $1.40 to about $1.10 during this period, meaning that a €10 bottle of wine would have moved from $14 to $11 if the exchange rate effect was fully realized.

That is a substantial price shift for a bottled wine. Price changes like this can be especially important in the bulk wine market where margins are sometimes just pennies per liter and small changes can shift competitive advantage from one country to another.

The euro’s fall has a lot to do with monetary policies. The U.S. Federal Reserve is raising interest rates while the European Central Bank has pushed them into negative territory. Other currencies that are important to the wine industry such as Australia, Chile, and South Africa have also fallen but due instead to China’s slowing growth.chile peso

When China’s growth began to stumble, it affected natural resource imports from Australia, Chile and other countries, reducing the demand for their currencies and pushing the value down as the next two charts show.

The result is that both the Australian dollar and the Chilean peso are much cheaper making their wine exports relatively cheaper to dollar buyers both in the U.S. and in some other countries. This is one reason why Australian wine exports rose to their highest level since 2007.

Chilean exports and those from New Zealand and South Africa have also benefited from strong dollar/weak local currency effects. How has this affected U.S. imports from these countries?

Imports in the U.S. Market


US Imports

Here is a snapshot U.S. wine imports for the first three quarters of 2015 as provided by Wine by Numbers, a publication of the Unioni Italiani Vini (click on the chart to enlarge). The numbers suggest that the exchange rate changes have had some effects, but that those impacts are different by market category and country. And they also show that the exchange rate is far from the only thing that affects the wine market.

Take sparkling wine, for example. Overall imports of sparkling wines grew by more than 21 percent by volume and 19 percent by value during this period while average unit prices fell. This pattern has the Econ 101 textbook direction, but the magnitudes are much higher than you would expect if the exchange rate was the only factor. Sure enough there is something else going on — the Prosecco boom that has broadened the whole sparkling wine category. The cheaper euro certainly aided this process, but it wasn’t the whole story by any means.

Now look at bulk wine imports. As I noted before, bulk wines in the past were more sensitive to exchange rate changes than other types of imports, so looking only at the strong dollar you would expect a big increase in bulk imports. But instead we see a dramatic decrease in bulk imports (although this varies by country). Yikes! What’s going on here?

As with sparkling wine there are other factors than the exchange rate at work. U.S. producers have substantial existing  inventories of bulk wines and are less interested in imports now, even if prices are attractive. The demand for wines selling for $9 and less has been declining in the U.S. market in the last two years and large harvests in the Central Valley have reduced the need for imports substantially. The strong dollar has probably kept bulk wine imports from falling even more but foreign currencies would have to plunge dramatically to make higher bulk imports attractive.

Bulk versus Bottle

Finally, the market for bottled wine imports shows rising import volumes and falling import expenditures and prices, which is what the textbook analysis would suggest for products with an inelastic demand. The question here is why didn’t imports rise even more?  The inventory/depletion/reorder time lags in the wine market are one reason.

But a more important factor is the reality of brand strategy pricing for higher-priced bottled wine products. One lesson of the financial crisis is that once your reduce sticker price it is hard to persuade consumers to pay more again. As a result, I suspect that many import producers are absorbing some of the exchange rate changes in the form of higher margins or spending it on importer and distributor incentives rather than retail price cuts. Some of the growth we see here is from new entrants (and re-entrants) into the market (and there are many of them) who are taking advantage of the exchange rate to launch campaigns in the U.S. market.

So, as you can see, the exchange rate has been a factor, but the picture is complicated. It is even more complicated if you break it down country-by-country. Come back next week for my take on the export side of the equation.

Will Argentina Wine Export Growth Return in 2016?

Last week’s column analyzed the reasons Argentina’s wine boom fizzled out. Wine exports to the U.S market have more or less plateaued since 2010 after a decade of rapid growth. Part of the problem, I wrote, is increased competition in the wine market, particularly from the so-called Red Blends that seem to have taken some of the momentum from Argentinian Malbec.

But the biggest factor has been Argentina’s domestic economic policies, which made it very difficult to do business and squeezed the margins of export industries, including wine. The squeeze has been particularly severe in the value wine categories, where the margins are so tight (or even negative) that Argentinian producers have been squeezed out.

Yes / No / Maybe?

Will Argentina wine growth in the U.S market return in 2016? Maybe is the answer, although 2017 looks like a better bet than 2016. The main reason for optimism is the change in government that took place in December 2015 when Mauricio Macri became President of Argentina, promising an end to the policies that crippled the economy, especially export industries like wine, and pushed inflation skyward.

The Economist magazine reports that Macri is “off to a fast start,” removing export taxes and allowing the peso to fall from its artificially high level. These actions will benefit exporters, but also send a shock to the domestic economy through higher interest rates and a short-term boost in the inflation rate due to rising import costs.

Argentina’s wine industry it likely to be twisted in 2016, with falling domestic economic activity offset by the exchange rate’s boost for exports. Growth in both domestic and export markets will have to wait until 2017 and beyond.  Good news under the circumstances even if it is far short of an instant cure for the ailing industry.

Like a Normal Country

But some of my friends in Argentina tell me that they are not expecting a miracle. They just want Argentina to be “like a normal country,” as they put it, in terms of its politics and economics and perhaps that’s what they will get.

If “normalization” works, will Argentina’s wine boom return to the U.S market? Perhaps, but things have changed and adjusting the macroeconomic levers won’t turn back the clock entirely. Argentina will come back, that’s for sure, although it will take a while for the foreign exchange and other factors to be fully felt  But don’t expect a return of the boom.

The best that Argentina should hope for — and it is actually a good thing — is to be like a “normal country” when it comes to the U.S. wine market. By this I mean that its exports are driven by the normal factors and not subject to booms or crises. Being a normal country in this context suggests a focus on the $10 and above price points, because that is where market grown and margin opportunities are.

A recent Rabobank report on Argentina’s wine sector notes that the reforms will allow more competitive pricing for Argentine wine exporters, but cautions against a rush into the value wine segment where Argentina used to be strong. “There are now opportunities to be more flexible with pricing,” Rabobank’s Stephen Rannekleiv notes, “but these need to be managed carefully in order to avoid undermining the long-term premium positioning of the brand and the overall category. … Excessive pricing moves may allow for windfall profits today, but could create headaches in the long run.”

And being a normaql country also means resisting the temptation to define Argentina as Malbec-ville. I know the temptation to adopt a particular grape as a region’s “signature variety” is strong, but I don’t see it as the best path for the industry.

Three-Dimensional Argentina

Argentina has Malbec, and that’s a good thing. But before the growth slowed smart Argentinean producers were already trying to add dimensions to their market space. Terroir is an obvious dimension that is even more important in signalling quality and  authenticity than it was a few years ago. I think many consumers now look for region — Uco Valley? Salta? — and especially elevation (Malbec develops differently in Argentina depending on the vineyards’ altitude) as quality indicators.

Another way to add dimensions is to exploit grape varieties beyond Malbec. There are so many wines that do well in Argentina besides Malbec and Torrontes, the two “designated” signature grapes. I love Mendel’s old vine Semillion, for example, And we recently surprised a Syrah-loving friend at a local Argentinean restaurant by ordering a higher elevation Syrah from the Uco Valley. He loved it, but would never have thought of  ordering an Argentine Syrah. Time to get that thinking started.

The options are nearly endless, as we learned a few years ago when we visited Buenos Aires and had lunch with sommelier Andrés Rosberg (you can read about the lunch here).  Andrés knew that we would taste many Malbecs during our visit and he wanted to be sure that we understand that Malbec was only the most visible part of the story — not the whole story and maybe not even the best story.

No Sure Things

So he served us a line-up of wines that featured everything except Malbec and it was great. Lesson learned and it was reinforced as we met with winemakers and tasted distinctive Chardonnay, Cabernet Sauvignon, Cabernet Franc and even Bonarda. Malbec? Yes and that’s a good thing. But a lot more, too.

This is an age of discovery for wine and Argentina has much to discover, both within the Malbec terroirs and beyond Malbec. That’s the sort of strategy that “normal countries” are embracing in the U.S. wine market today.

Argentina has little experience as a normal country, making its way without crisis or drama. The success of Macri’s economic policies is not a sure thing since they depend on short-term sacrifice for long-term gains in an uncertain and even unstable global economic environment. It won’t be easy to become normal, but it is an important step.

Sometimes, as Argentina’s national soccer team has demonstrated, great players and great ideas can come to a disappointing end. I am optimistic, however, and hopeful that the wine sector gain will regain momentum while avoiding the boom-bust cycles of the past.

Butterfly Effect: How China’s Crisis Threatens the U.S. Wine Industry

china1“The Butterfly Effect” is a term coined by Edward Lorenz that describes the nature of a highly interconnected system such as the global environment or the global economy. A butterfly beats its wings in Brazil, the story goes, setting off a chain reaction that indirectly results in a tornado thousands of miles away in Texas.

The Butterfly Effect was on my mind last month when I spoke at the annual meeting of the California Association of Winegrape Growers in Napa, California. Part of my presentation outlined several indirect global threats to the California and U.S. wine industries. Two of these are in the news this week.

China Market Meltdown and Contagion

The financial crisis in China was one of the threats that I highlighted. “I know what you are thinking,” I told the group, “Mike, we don’t have a lot of money in the Chinese stock market and we don’t really sell too much wine in China, so I don’t see how falling Chinese stock prices are a threat to our business.” Well, they aren’t much of a direct threat, it’s that Butterfly Effect that you need to worry about.

Economists have a name for the Butterfly Effect of a financial crisis — we call it contagion and it takes several forms. Exchange rates are one way that economic effects are transmitted from country to country.  The Chinese crisis drives down raw material prices on global markets and this has pushed down the foreign currency values of many natural resource producing countries including Australia, New Zealand and Chile.

These three countries are important wine exporters to the U.S. and lower exchange rates for their currencies means increased competition for U.S. producers. When you find that a Chilean producer has undercut your price for bulk Cabernet Sauvignon, for example, there might be a Butterfly Effect at the root of the problem.

Oil is another potential contagion vector. As China slumps, oil prices do, too. This has a disproportionate impact on certain countries such as Russia, which relies on oil exports to China more than in the past due to the current international  sanction regime. When Russia also slumps due to falling oil sales wine producers in Spain, for example, find themselves stuck with excess stocks earmarked for the Russian market. If they try to sell them off here in the U.S. at a bargain price that’s another Butterfly Effect to consider.committee

The Contagion-Busters

Contagion occurs in other ways and I highlighted the group that I think of as  “The Committee to Save the World” (shown above) in my Napa talk (you might prefer to call them the Contagion-Busters). The “Committee’s” job is to stop contagion or at least minimize its effects and it is a difficult task. They have been focused on Greece in recent months, but now it is impossible for them to ignore China.

Hopefully they can prevent the Chinese crisis from having real impacts on other large economies. It is already clear that there have been substantial financial effects (the U.S. stock market “correction,” for example) but the real economy of jobs and output is slower to react and sometimes is less affected. Fingers crossed.

Certainly the Chinese crisis adds risk to the whole world economic system and puts constraints on policy. If the Federal Reserve now goes forward with its widely anticipated plan to raise interest rates in September, for example, the result is likely to be a big spike in the value of the U.S. dollar on foreign exchange markets, putting U.S. wine producers at a further competitive disadvantage. Another beat of the butterfly’s wings?

Keep an eye on China. The impacts could be both bigger and different than you otherwise expect.

Exchange Rate Lessons from Australia’s Wine Boom and Bust

Kym Anderson (with the assistance of Nanda Aryal), Growth and Cycles in Australia’s Wine Industry: A Statistical Compendium 1843-2013). University of Adelaide Press, 2015. (Available as a free pdf download — follow the link above.)

ozKym Anderson’s new book on the five major boom-bust cycles of the Australian wine industry is a landmark wine economics study. Like all of Anderson’s work, it is data-driven and provides both the casual reader and focused student with a wealth of information.  A detailed Executive Summary is followed by 73 pages of analysis (and ten more of references), 86 revealing charts and more than 450 pages of tables.

Answers and Questions

I’m not sure I have ever seen such a detailed account of what happened to a wine industry, when, where and how. The data span the decades, regions, grape varieties, international regimes and economic cycles.  Such a wealth of information is valuable both for its ability to answer questions and for the way that it provokes them.

I won’t attempt to summarize Anderson’s big volume here (Andrew Jefford did a great job of this in his Decanter column) but I thought I might illustrate the sort of focused analysis that the book makes not just possible but convenient.  We are always looking for lessons from history and I think Australia’s wine business cycles are useful in this regard, especially the fifth cycle, which began in 1986 and continues today.

Exchange Rate Effects?

Anderson describes the recent collapse of the Australian wine industry as the result of a “perfect storm of shocks” including drought and rising irrigation water prices, the global financial crisis, the rise of the Australian dollar (driven by mineral exports to China), increased competition from other wine-exporting countries, and China’s austerity policies (which have reduced demand for luxury wine products). He could have added vineyard  heat spikes, wildfires and the gradual but significant effects of global climate change to the list of challenges. Perfect storm, indeed!aud

Since we are currently experiencing a period of major exchange rate realignment, with the U.S. dollar on the rise and the Euro seemingly in free fall, I thought it would be useful to tease out the many ways that the Aussie dollar impacted its wine industry in recent years.  According to news reports currency instability was the hot topic at the ProWein wine fair this year, so analysis of the possible effects is timely. Here are some brief points taken from the Executive Summary.

  • The 1986 boom began, Anderson tells us, as a response to the historically low value of the Australian dollar (hereafter abbreviated AUD), which encouraged exports by reducing their price to foreign buyers. The AUD’s low value was due to falling prices for mineral exports.
  • Wine exports boomed, rising to 2.3% of all Australian exports by 2004.
  • Wine prices increased, stimulating vine plantings, higher production and more exports but higher prices also  limited domestic wine market growth making Australian producers more dependent on export markets.
  • Rising exports increased the incentive for investment in developing overseas markets for Australian wine, both through generic marketing and private brand promotion. Meanwhile, other countries also began to expand wine exports, too, contesting key market spaces.
  • The AUD began to rise in 2001 (driven by Chinese mineral demand). Competition in export markets made it difficult to pass through rising foreign exchange costs to export customers, so much of the burden was passed back in the form of lower AUD export receipts and, in due course, lower wine grape prices.
  • Meanwhile, the strength of the AUD made imports cheaper, including wine imports, which increased dramatically. Especially affected were Sauvignon Blanc imports from New Zealand and Champagne imports from France.
  • New Zealand Sauvignon Blanc became the best-selling white wine in Australia. Not the best-selling imported white wine. The best selling-white wine, period!
  • Wine grape prices collapsed and the value of vineyard land fell, in some cases to the same low value as unimproved farm land. This is the bust that the Australian industry is still recovering from.

Lessons for the U.S. Today?

The exchange rate isn’t the whole story of Australia’s fifth wine cycle by any means, but you can see that it had important effects. The long term instability in the exchange rate translated into booms and busts in wine exports, imports, wine prices, grape prices, land prices and so on.

Anyone who thinks the current rise of the U.S. dollar won’t impact the U.S. wine industry or have global repercussions should take a look at Anderson’s study of Australia. The U.S.story will be different, and the impacts less just because our domestic market is so much larger, but there will be significant impacts.

This is just one of the analytical threads in Kym Anderson’s important new book. I invite you to dig and see what questions his work raises and what lessons you can learn.

How Will the Rising Dollar Affect the U.S. Wine Market?

fxHow will the rising dollar affect the U.S. wine market? The answer, predictably, is that it’s complicated. Read on for analysis organized around three questions. Why has the dollar appreciated? What are the textbook effects of a rising dollar? How and why is the impact on U.S. wine likely to be different?

Why has the dollar appreciated?

The U.S. dollar has appreciated dramatically on foreign exchange markets, powered by several factors. Expectations of higher interest rates in the U.S. is a big part of the story as the reality of the end of the Federal Reserve’s asset purchase program sinks in. Add to this the fact that the Europoean Central Bank is finally close to beginning its own quantitative easing program, which will keep rates down on that side of the pond. This combination is a recipe for the sort of change you see in the graph above.

The relative strength of the U.S. economy, weakness of the E.U.with its potential “triple dip” recession and uncertainty regarding China and oil prices all contribute to the economic environment that has helped fuel the dollar’s recent rise. Where is money going to go in a risky world? Can you say USA? A lot of us have been impatiently waiting for the dollar to move higher for a couple of years. Now that it has happened, what should we expect?

What are the textbook effects of a rising dollar?

The classic textbook effect of a rising currency is that imports increase because they are relatively cheaper and exports decline because they are costlier to those holding foreign currencies. Imports up, exports down. That’s where the Econ 101 story often stops, but the situation is a little more complicated.

Prices adjust faster than quantities in most cases. Price effects (rising export costs, falling import prices) tend to happen quickly, but quantities take longer to change because of inventory lags, recognition lags, and contract lags. Basically, it takes time before the new exchange rate translates into real actions because existing inventories must be depleted before new orders are made, because it takes some time before economic actors feel certain that the change is sustained and not just a market blip, and because existing contracts often preclude immediate adjustments.

These lags create what economists call the “J curve” effect, with opposite short-term and long-term payments impacts. The Econ 101 results take longer to show up in significant amounts than you might think and even then will only appear if other intervening economic factors don’t offset them. So predicting the short term impact of an exchange rate change isn’t as simple as you might think even if you earned an “A” in Econ 101.

But price is a powerful force, and the fact that a rising dollar makes our exports more expensive to foreign purchasers (and imports cheaper for U.S. buyers) should not be ignored even if immediate run impacts are not obvious. Don’t expect everything to change at once.

One more complication is that although we like to talk about the dollar rising or falling, the overall trend conceals the fact that the dollar might be higher relative to one currency and still falling compared to another. During one recent period when the dollar was quite weak by some standards, for example, it still rose compared to some other currencies that were even weaker.

How and why is the impact on the U.S. wine markets likely to be different?

Given all this, it is instructive to read a 2012 report by Kym Anderson and Glyn Wittwer titled “Studying the impact of exchange rate movements on the world’s wine markets, 2007-2011” (a University of Adelaide Wine Economics Research Centre working paper — the link takes you to a pdf of the paper). The Anderson-Wittwer study examined the impact of exchange rates on wine trade during a period when the dollar was falling instead of rising and finds that the impact of exchange rates was different in different import markets and in different wine market segments. (I told you it was complicated!)

In the U.K. market, for example, the exchange rate impacts were pretty much what theory suggested both in terms of import effects and distribution among different wine exporting countries. A good textbook case.

But the U.S. was a different story, as you might expect given that we have a substantial domestic wine production base and that we both export and import wine with the two trade flows connected to a certain degree by the “wine drawback program”  (Click here to read a 2012 UC/Davis report on the drawback program.)

The wine drawback program allows a refund of 99% of import duties and excise taxes on wine for which the importer has matching exports of commercially “interchangeable” wine. Because per-unit import duty and excise tax rates are substantial compared to the price of bulk wine, use of the program is high for bulk wine imports, which compete with wine from low-price Central Valley grapes. Bulk wine exports dominated imports until 2009 and the program stimulated import growth. Now, with imports and exports roughly in balance, the program stimulates both exports and imports—leaving net trade in bulk wine roughly in balance.

– Summary of the U.C. Davis Report

The Anderson-Wittwer study found that the falling dollar had different effects on U.S. consumption of  Old World and New World wine imports during 2007-2011. Old World imports increased despite the dollar’s fall and New World imports fell.  Obviously the price effects were more strongly felt for New World wines than for Old World products (see Table 6 of the report) and although Australia accounted for much of the import decline and may be a special case in some ways, Argentina, Chile and South Africa were also negatively affected.

The study found differences by price category, too. Non-premium and commercial premium New World wines were the most affected by the exchange rate changes while super-premium wines showed less impact. This makes sense because the lower priced products are often part of the bulk wine trade, which has become highly efficient, facilitating ease of substitution from one country’s products to another. A small change in cost can have a big impact on the size and direction of trade. Textbook effects rule here.

More expensive products benefit from greater product differentiation. The power of an established brand acts as a shock absorber when costs increase, although there are obvious limits to this.

It’s Complicated

So if Old World imports increased and New World imports fell during the period when the dollar was slumping, can we expect just the reverse now that the dollar is soaring? It would be great if we could just take the Anderson-Wittwer numbers and change the signs from plus to minus and so forth, but life is more complicated than that. Anyone who has tried to sell wine can tell you that it is easier to lower a price than to increase it! It’s a kind of hysteresis in the sense that where you can go now depends on where you have been. You can’t just back out to where you started.

That said I think there are important insights to take away here, key among them is the idea that the impacts are likely to be different for bulk wine and packaged good trade and for Old and New World products.

Textbooks and research give us good guides to understanding the impacts, but there aren’t any simple answers. And the exchange rate isn’t the only thing that’s changing this time around. I know a number of New World producers who made big bets on the Russian market, for example. Seemed like a good idea at the time, but my how things have changed! They’ll be desperately  looking for markets for the wine they can’t sell to Moscow. And imports from Argentina may be more affected by that country’s domestic policies (and the upcoming elections) than exchange rates.


It occurs to me that this column is a classic example of what Paul Krugman once called “up and down economics.” This goes up, that goes down, and so on. Made me think of the Winslow Homer painting “Right and Left” that you can see in the National Gallery in Washington D.C.